What Happens to Your HELOC if Your Home Value Drops?

A home equity line of credit (HELOC) lets you tap into your home equity—the percentage of your home’s value that you already own—using the house as collateral. HELOCs are attractive because they provide easy access to cash for renovations, debt consolidation, medical bills, and other expenses. However, there’s a catch: Because HELOCs are tied to home equity, your lender can freeze or reduce your credit line if your property value drops. 

What Is a Home Equity Line of Credit (HELOC)?

A HELOC is a revolving credit line much like a credit card, except your home secures it. Because a house serves as collateral, HELOC interest rates—which are variable, not fixed—tend to be more favorable than those for credit cards and personal loans. 

Your lender approves you for a certain amount of credit based on your home equity, credit score, debt-to-income (DTI) ratio, and other factors. As long as you stay under your credit limit, you can borrow whenever you need money, tapping the funds via online transfer, cash withdrawal from your local bank branch, or a check, an ATM card, or a credit card tied to the account.  

How Do You Repay a HELOC?

HELOCs generally have two stages: a draw period and a repayment period. 

The draw period usually lasts 10 years, during which time you can borrow up to your credit limit, repay it, and borrow again as often as you wish. During this stage you pay interest on your borrowed amount or make a minimum monthly payment (per your loan agreement). You might also be able to make payments toward the loan principal, lender permitting. 

When the draw period ends, the HELOC closes, meaning you can’t draw any more money, and shifts to the repayment period. You’ll make monthly payments to pay down the principal and interest, generally over 20 years. The size of your payment will depend on your outstanding balance at the end of the draw period and the prevailing interest rate. Some HELOCs have a balloon payment, meaning that the entire amount of the loan plus interest comes immediately due at the end of the draw period.

HELOCs and Declining Home Values

As mentioned above, your HELOC credit limit is tied to your home’s value, among other numbers. While your lender considers the value of your home when you apply for a HELOC, it evaluates your credit line and ability to make payments over the entire loan term. If something has changed dramatically since you secured the loan, your lender can reduce or freeze your HELOC.  

Should that happen, you won’t be able to draw your credit line’s total amount (or any part, in the case of a freeze). However, you’ll still be on the hook to fulfill your loan agreement, including making monthly interest payments.  Some of the most common reasons a lender might reduce or freeze your credit line are that your:

• Credit rating has dropped
• Employment or income status has changed
• Overall debt load has increased
• Marital status has changed
• Home’s value has declined significantly

Your lender must send you written notice within three business days after it reduces or freezes your HELOC. If the lender’s reasoning doesn’t make sense to you, ask for a detailed explanation and if there’s anything you can do to restore your credit line.

You can appeal the decision if you think the lender has made a mistake—for example, your home is worth more than your lender realizes because you made substantial improvements recently. Of course, your lender will expect an updated home appraisal if you want to appeal based on your property’s value. However, keep in mind that the appraisal fees will be your responsibility, and, more important, an updated appraisal won’t guarantee that your lender will approve your appeal.

If your lender doesn’t restore your HELOC, you can check with other lenders to see their offerings. You might be able to open a new HELOC and use some of the funds to pay off your original line of credit. 

The Bottom Line

Property values tend to rise over time. Still, rising mortgage rates, supply increases, demand decreases, recessions, and other events can lead to lower prices. If your home’s value drops a little, your lender probably won’t reduce or freeze your HELOC, as slight market fluctuations are normal. It’s when your home’s value substantially changes that your lender might take action to limit its risk.